JOBS Act: Debating the Benefits for Startups, Risks for Investors

April 5, 2012 at 12:00 AM EST

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President Obama signed the JOBS Act Thursday and called the law -- aimed at helping startup firms raise capital -- a "game-changer." Opponents said the law rolls back investor protections. Jeffrey Brown leads a debate on the the law's intentions and risks with CareCloud's Albert Santalo and Columbia Law School's John Coffee.

JEFFREY BROWN: The White House Rose Garden was a rare scene of bipartisanship today. Democrats and Republicans looked on as President Obama put his pen to a bill meant to spark startup companies.

(APPLAUSE)

PRESIDENT BARACK OBAMA: Thank you.

JEFFREY BROWN: It wasn’t the much broader jobs package that he called for months ago, but the president said the bill he signed today is a — quote — “game-changer” just the same.

BARACK OBAMA: This bill represents exactly the kind of bipartisan action we should be taking in Washington to help our economy.

I have always said that the true engine of job creation in this country is the private sector, not the government. Our job is to help our companies grow and hire.

JEFFREY BROWN: The JOBS Act supporters in Congress argued it will create jobs by helping startup firms raise capital. Under the Jumpstart Our Business Startups, or JOBS law, such companies have longer exemptions from disclosing financial information and don’t have to register with the Securities and Exchange Commission until they have 2,000 shareholders, instead of the current 500.

The statute also permits so-called crowd funding, allowing small online sales of stock to a large number of investors. But there have also been concerns that the law rolls back investor protections. Last month, SEC Chair Mary Schapiro sounded a warning in a letter to senators.

She wrote, “If the balance is tipped to the point where investors are not confident that there are appropriate protections, investors will lose confidence in our markets, and capital formation will ultimately be made more difficult and expensive.”

Today, the president vowed not to let that happen.

BARACK OBAMA: Of course, to make sure Americans don’t get taken advantage of, the websites where folks will go to fund all these startups and small businesses will be subject to rigorous oversight.

The SEC is going to play an important role in implementing this bill. And I have directed my administration to keep a close eye as this law goes into effect.

JEFFREY BROWN: To that end, the president called on Congress to fully fund the SEC.

And we get two views of the new law now from Albert Santalo, founder and CEO of CareCloud, a health information technology company based in Miami. He attended the White House ceremony this afternoon. And John Coffee is a professor of law at Columbia Law School specializing in corporate and securities law. He testified about the new law on Capitol Hill.

Albert Santalo, I will start with you.

Why is this bill a good idea? How would it help you, someone like you?

ALBERT SANTALO, CEO, CareCloud: Jeff, it’s great to be here.

You know, for the last 10 years since the passing of Sarbanes-Oxley, the whole venture world has changed, entrepreneurship itself has changed. And this legislation really helps to — entrepreneurs to access the needed capital that they so kind of thirst for at the beginning of companies.

I think this helps democratize the whole entrepreneurial initiative so more and more people that either because of fear or access to resources can now access the world in terms of investment to get their companies and their ideas going.

JEFFREY BROWN: But how does it do that specifically for a company? What will you be able to do now that you couldn’t do?

ALBERT SANTALO: In CareCloud’s case, it’s a little bit different.

We can take advantage of things like what’s called the IPO on-ramp part of the legislation, which allows companies to not have to comply fully with Sarbanes-Oxley until five years into their initial public offering.

If you look at the way things worked before Sarbanes-Oxley, smaller companies had access to the public markets and the capital that that brings. And that whole effect goes downstream back to the early-stage investors, venture capital. All of those investors have now swum upstream because their investment horizons have all changed.

The asset class of venture capital in itself has been impacted. It hasn’t performed well in the last 10 years. This changes things because now investors, which is — you know, investors work in stacks where one set of investors, angels, pass it on to venture, which then pass it on to public and so forth.

It makes that stack more efficient. And so a company like CareCloud, which is kind of fighting with companies that — in health care technology which have been around for in some cases 40 years, it makes them have to become more competitive because now companies like us can access public capital much earlier.

JEFFREY BROWN: All right. So, John Coffee, you’ve been looking at this for a long time, Sarbanes-Oxley, of course, referring back to the post-Enron scandal issues. What concerns do you have with this new law?

JOHN COFFEE, professor of securities law, Columbia University Law School: Well, reasonable people can disagree about Sarbanes-Oxley and a number of other revisions in this bill. There are good things and bad things.

But what’s really fundamental is this bill undoes what has been the key overarching principle of our system of securities regulation for 80 years or more. And that key principle is Justice Brandeis’ rule that sunlight is the best disinfectant, electricity the best policeman.

We let people take high risk, but we compel disclosure to them. That is about to change because under the JOBS Act, we’re retreating from this principle of transparency and we’re allowing a large number of companies, some of them quite sizable, with potentially billions in assets, to sell stock to the public, and then cut off all further disclosures, because, under this statute, as long as you do not have 2,000 shareholders of record — and I stress the word of record — there’s no obligation to say anything more to them.

You can just make voluntary disclosures, tell them the good news, not the bad news. And the sad truth is — which Congress didn’t want to realize, is that you can manipulate that 2,000 shareholder of record level. You can have 20,000 beneficial shareholders holding the stock in street name. That is, you can hold the stock through Merrill Lynch, Fidelity, your broker, and although Merrill Lynch might hold stock for 5,000 investors, they’re only one shareholder of record.

As a result, those companies that want to hide, that want to go dark, can do so. And what I have to tell you, from a great deal of experience, is that bad things happen in the dark. When a company ceases to make disclosure, there may be unfair self-dealing transactions, there may be illegality, there may be foreign corrupt practices that they want to engage in and not disclose.

There are special incentives to go dark, make no further disclosures, but be able to sell your stock to the public.

JEFFREY BROWN: All right.

JOHN COFFEE: Not all companies will do that, but some will.

JEFFREY BROWN: Well, Mr. Santalo, how do you respond to that, that the fear is I guess that investors will be putting in money, they don’t know what they’re putting it into, and they can lose a lot of money?

ALBERT SANTALO: Well, I agree that transparency obviously is very, very important in all business dealings. And that’s true of companies of any size.

So a company like CareCloud that access private capital and then venture capital, you know, we’re very transparent about the things that we do. And if we weren’t, we wouldn’t have that capital. You know, the 2,000 shareholder kind of limit, that’s really for private companies. Most private companies don’t have 2,000 shareholders or 500 shareholders anyway.

And things have been circumvented, from my understanding, regardless of that. For instance, Facebook has one investor, one shareholder called Goldman Sachs that then has shareholders behind it. So there are ways to circumvent this stuff anyway.

I’ve heard some incredible things about increasing those limits to 2,000 shareholders or — so that community banks can issue shares to their employees, which they haven’t been able to do. Make their employees owners of the business.

JEFFREY BROWN: But is your argument that it’s worth doing even though investors might lose some protections, it’s still worth doing because it will help companies like yours and therefore promote jobs?

ALBERT SANTALO: Yes. There’s no silver bullet in any of this stuff, right? So it’s a balancing act.

The transparency has also changed in the last 80 years, right, since the Securities and Exchange Act. We live in a much flatter world. The Internet has changed everything. Nobody — everybody has to kind of protect their personal brand. You can’t just defraud people in Atlanta, and move to Arizona and start over with a clean slate these days.

So the Internet and these crowd funding platforms that are emerging are going to help to do things differently, but not necessarily lose transparency. It’s just that the transparency will be different.

JEFFREY BROWN: Well, Professor Coffee, it sounds like you think, now, they haven’t changed that much. There’ll be ways to hide investigation from investors.

JOHN COFFEE: I think many companies — most companies want to do the right thing.

The problem is, these exemptions were overbroad. You could have given a lot more room, a lot more freedom from Sarbanes-Oxley for new startup companies. But you have written some permanent rules now that allow those companies that want to hide in the dark to do so. And we have given very overbroad exemptions.

The point has been made just now that Internet startups and IPOs have been down for the last 10 years. Well, they have been down because an IPO bubble burst in 2001, and in the wake of that burst, we found that conflicted securities analysts were making very inflated recommendations to please their underwriter bosses.

That’s what Eliot Spitzer uncovered. Reforms were put in place, and now we’re repealing all of those reforms. And we’re going to see the people who were famous 10 years ago, the — Mr. Blodget and Mr. Grubman and others who made inflated recommendation. They and their successors can come back to this business.

Congress is in effect saying, welcome back, go and sell stock your old-fashioned way by promoting it with inflated recommendations. That may work for a couple offerings, but that’s a short-term perspective. You will lose investor confidence. And when you lose investor confidence, the cost to capital goes up and all companies will be hurt.

JEFFREY BROWN: Well, let just me ask you in our last minute here, briefly, both of you, where does that leave investors? There’s always a buyer beware, right? But what now, Mr. Santalo?

ALBERT SANTALO: So investors have a choice. Nobody’s putting a gun to an investor’s head and saying go make this investment.

Even in the last 10 years, the world has changed. So there was this thing called the Internet bubble, which was a lot of people speculating what could be possible and investing ahead of the curve. But we can now see that a lot of — that the model works. You can create an incredibly scalable and valuable business on the Internet today, in a way that you couldn’t do in the late ’90s.

And so analysts doing their jobs well, that’s something that the investment houses and the analysts — there has been reform around this, but they have to do that well. And investors have to be educated on any type of investment that they’re making, whether it be $10,000 or $10 million. It doesn’t really change.

But, at the end of the day, management teams — so we talk about Sarbanes-Oxley and the reform and so forth, but at the end of the day, regardless of the Sarbanes-Oxley compliance issues, management teams have fiduciary duties to their investors. And they have to — they can have criminal charges and so forth related to not doing things the right way. That doesn’t change.

JEFFREY BROWN: All right. All right.

Professor Coffee, a last word for investors?

JOHN COFFEE: The gentleman has just told you that self-regulation is good enough. It’s not.

You do need some mandatory rules. And this legislation not only curbs SEC authority. It tells a variety of basically sensible self-regulators, the Financial Accounting Standards Board, the Financial Industry Regulatory Authority, and other self-regulators, they no longer have any authority over these emerging growth companies.

Some of them will prove to be very successful. Others will be serious scandals. And the bad ones have a way of stigmatizing — the bad apple ruins the whole barrel. So I would say, for investors, stick with those companies listed on exchanges. There, you will still get full disclosure. But be very cautious about companies that are not willing to go all the way and become full-scale reporting companies.

JEFFREY BROWN: All right, John Coffee and Albert Santalo, thank you both very much.

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